Physician mortgage loans tend to get positioned as a no-lose product that you’d be crazy to pass on
All the benefits of traditional mortgages but without the big down payment and at no extra cost. Add in the special provisions designed specifically for doctors and you’ve got the Swiss army knife of mortgage loans. Sound too good to be true? Maybe.
Physician loans aren’t always bad. In fact, in many cases the product works well. But they also come with some baggage that you’ve probably not thought about. Here is our list of five of the biggest supposed benefits of the physician mortgage loan that are actually major downsides.
1) Easy Physician Mortgage Loan Approval
With Physician home loans, you can qualify for the home you love even before starting residency. They’re designed to make it so easy to buy - maybe too easy. Think about buying a car. Everyone knows that car dealers sell the monthly payment. Why? Because they want the decision to be as easy as possible for you to make. It’s much easier, psychologically, to make a decision to buy a car for $299/mo than it is to make a decision to buy a car for $35,000.
Home loans for physicians are the same way except they sell the monthly principal and interest payment. You can buy a $500K home for $2998/mo (monthly principal and interest payment for a 30-year mortgage at a 6% fixed interest rate). $2998/mo sounds doable. Maybe you’re already used to paying that much in rent. Why not buy a home instead and start building equity? But that’s not the full story. You have to consider all of the other expenses that come with owning a home: insurance, taxes, maintenance and repairs, utilities, landscaping, furnishings and association fees.
Lenders will gladly qualify you for a physician mortgage loan up to the level where your total debt payments approach 45% of your pre-tax income. It may seem like this number is fine because you’re coming in under their “limits”. But you should realize their limits calculate the limit you can afford and still eat (barely). For most people, symptoms of being house poor show up when debt to income exceeds 35%. When you get up to 40-45%, it gets bad. It’s so easy to get into this spot if you’re not careful.
2) Zero Down Payment
I know it sounds appealing on the surface, but owning a home with zero equity (no down payment) is dangerous. In fact, if you put zero down, you’re actually starting out underwater (underwater = loan balance is higher than the home value) because you indirectly pay considerable transaction costs when you buy or sell a home. But maybe you’ve heard the pitch that housing prices in your area always go up and your home will be a great investment. People are quick to forget the recent past.
In 2008 and 2009, housing prices across the country dropped considerably in value. Specific regions dropped even more than the overall US. For example, California, Nevada and Florida saw the biggest declines in excess of 40%. And then certain cities saw even bigger drops. Las Vegas was one of the cities hit particularly hard. These quotes from the Las Vegas Review-Journal show how bad it was: “Existing homes lost more value than new ones. Of the roughly 3,000 existing homes bought in the peak month, the median loss was almost $190,000, or 65 percent. Of the almost 1,900 new homes bought in the peak month, the median loss was more like $182,000, or almost 60 percent.”
This statistic from a 2011 Business Insider article paints the picture well: “As of the end of 2010, 23.1 percent of all U.S. homeowners with a mortgage owed more on their homes than their homes were worth.” Another article written around the same time from Reuters, “Home Price Drops Exceed Great Depression: Zillow” (a 26% drop since their peak in 2006).
The housing market can and will go down. If this happens when you happen to be in the first few years of a physician mortgage loan, you’re going to be in major financial trouble. It’s better to go into this decision understanding this risk.
3) Exclude Student Loans During The Doctor Mortgage Loan Underwriting
Physician home loans allow you to qualify for a home mortgage without consideration of your massive future student loan payments looming. This is great if your sole goal is to own a home during residency. However, if you’re not careful, it’ll cost you tens of thousands on your student loans.
The average mortgage lender will always look at your student loans and want to consider the eventual payment when approving your mortgage. So, it can be tough to qualify for anything if you owe $400K in student loans. However, mortgage lenders have figured out how this all works. They know about the grace period and forbearance for medical residents. They know if they can get you in the home before the loans kick in (grace period), and if you make an uninformed decision and buy too much home, you can always forbear the loans until you go into practice. Therefore, taking the loans off the table is a no risk decision for them. However, it can hurt you.
Here Is What the Scenario Looks Like
You’re graduating from med school, and your first priority is buying a home. So you look at physician mortgage loans. In talking with a lender, you learn the max amount they’ll loan you is way higher than your price range. Mentally, this makes you feel better about buying in the price range you had initially intended. So you move forward. In getting formally approved, the lender instructs you to not mess with your student loans (which are in grace period) until the deal closes. You don’t think much of it; everything goes smoothly and you’re now in the new home and starting residency. However, what you didn’t realize was that there is absolutely no chance you’ll be able to make any student loan payments during residency with your newly established living expenses (most of which is the home). So you’re forced to forbear on your student loans until you go into practice. What’s the damage? The average medical school grad is throwing away $5-20K by going through grace period (instead of skipping it). They’re throwing away another $50-100K by forbearing during all of residency. A better way to do this would be to figure out the best plan for your student loans before you go down the mortgage path. Always structure your mortgage around the student loan repayment plan (as opposed to the reverse).
4) Physician Mortgage Loan With No PMI
With most mortgages, if you don’t have at least 20% equity (or put 20% down at purchase), you’re required to pay private mortgage insurance “PMI”. This is a pure cost that can easily be several hundred per month. However, the doctor mortgage allows you to avoid PMI even though you start out with 0% equity. But what lenders don’t tell you is it’s typically not really the lowest interest rate option available. Physician mortgage loans are normally 0.25% to 0.50% higher than the lowest rate 20% down alternative loan. The problem is most of these alternatives require 20% down. However there are some less common 0% down alternatives to consider that can sometimes have a lower interest. For example, the VA loan (especially if you’re disabled). Make sure and check out all your alternatives before proceeding with the loan.
5) Tax Deductible Interest
Medical residents could really use a tax deduction. Why not buy a home instead of renting so that you can begin to take advantage of the tax deductibility of mortgage interest now? This is another classic physician mortgage loan selling point. But what you don’t hear is most residents won’t actually get any tax benefit from the mortgage deduction. They can put it on their return but odds are high they end up taking the standard deduction which is no different than if they hadn’t bought the house. For 2024, the standard deduction is $14,600 for single filers and $29,200 for a married couple filing jointly.
Important note about understanding lenders conflicts of Interest
Keep in mind that lenders are in business to make money. Your financial interests will always be secondary to their desire to close the deal. This is not to say that they’re bad people – not at all. In fact, most lenders we work with are nice, knowledgeable, and professional people. They’re very helpful in navigating the home buying process. But, remember who they work for. As much as they may tell you otherwise, they don’t work for you. They are sales people working to close deals for the lenders. So before you go down this path, remember this. You have to keep your own interests in mind or have an advisor like us keep an eye out for you. Otherwise, you could end up unknowingly making one of these classic physician mortgage loan mistakes.
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Wrenne Financial Planning is a registered investment adviser. The content of this blog post is intended for informational purposes only and is not intended to be investment advice. The views expressed in blog post are subject to change based on market and other conditions. Some information has been obtained/provided from third party sources and is believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.